Confirmed letter of credit: A vital tool for secure international trade

Last updated on 06 Aug 2024

24 Jul 2024 . 1 min read

Carter Hoffman

Carter Hoffman is a Research Associate at Trade Finance Global focusing on the impact of macroeconomic trends and emerging technologies on international trade.

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Confirmed letter of credit: A vital tool for secure international trade

A confirmed letter of credit (LC) is a crucial financial instrument designed to ensure transaction security between global trading partners in international trade. Given the inherent risks of cross-border commerce, such as political instability, currency fluctuation, and payment default, the relevance of this tool has only grown.

Key concepts of confirmed letter of credit

A confirmed letter of credit is an LC confirmed by a second bank, in addition to the issuing bank, which guarantees the payment to the seller under the agreement’s terms.

Parties involved: The primary entities include the issuing bank, confirming bank, buyer (applicant), and seller (beneficiary).

Types of confirmed LCs: Sight LCs, where payment is made upon presenting the required documents, and Time LCs, which allow for payment at a later date.

Risk mitigation: Explains how confirmed LCs reduce the risk for sellers by assuring payment under the agreed conditions from a financially sound bank.

Process and documentation: Details the step-by-step process from LC issuance to settlement, highlighting the necessary documentation such as bills of lading, invoices, and insurance documents.

Global impact and applications

Confirmed LCs are pivotal in facilitating secure and efficient international trade. By minimising the credit risk for sellers and enhancing the buyer’s trustworthiness, confirmed LCs enable smoother transaction flows and broaden market access even in volatile regions.

For example, a US company importing goods from a less politically stable country might utilise a confirmed LC to ensure payment security. Such financial instruments are integral in building resilient trade infrastructures worldwide.

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FAQs

What distinguishes a confirmed LC from a standard LC?

A confirmed LC distinguishes itself by involving an additional layer of assurance provided by a confirming bank alongside the undertaking of the issuing bank. This dual obligation enhances the security and reliability of payment for the exporter, mitigating the risk of non-payment or default.

When is it appropriate to use a confirmed LC?

A confirmed LC finds its appropriateness in international trade transactions where the exporter seeks heightened assurance regarding payment security. It proves particularly beneficial when navigating unfamiliar or high-risk markets, where the risk of non-payment or default is heightened.

How does the cost of a confirmed LC compare to a standard LC?

The cost of obtaining a confirmed LC may be marginally higher than that of a standard LC, given the involvement of an additional bank committed to honouring the LC. However, a confirmed LC’s enhanced security and reliability may outweigh the associated costs, especially in high-value or high-risk transactions.

What steps are involved in obtaining a confirmed LC?

Acquiring a confirmed LC typically involves collaboration between the exporter, the issuing bank, and the confirming bank. The exporter initiates the process by requesting the issuance of a confirmed LC from the issuing bank, which then engages a confirming bank to provide additional assurance. Upon agreement from both banks, the confirmed LC is issued to facilitate the trade transaction.

Can a Confirmed LC be amended or cancelled after issuance?

Amendments or cancellations to a confirmed LC require mutual agreement between the parties involved, including the exporter, the issuing bank, and the confirming bank. Any modifications to the terms and conditions of the confirmed LC must be documented and communicated clearly to ensure compliance and mitigate potential disputes.

Are there any restrictions on using a confirmed LC for specific types of transactions?

While confirmed LCs are versatile instruments widely used in international trade, certain transactions or industries may restrict their usage. It is essential for exporters to consult with their banking partners and legal advisors to ensure compliance with any regulatory requirements or industry-specific guidelines governing the use of confirmed LCs.

A confirmed LC is a cornerstone of international trade, offering enhanced security, reliability, and trust in transactions between buyers and sellers. By understanding its functions, implications, and practical applications, stakeholders can harness the benefits of the confirmed LC to navigate the complexities of global commerce, mitigate risks, and foster mutually beneficial trade relationships.